Wednesday, April 25, 2012

Huabao - a Chinese flavours and fragrances company in Hong Kong - has suspended trading after falling on a short-seller report. To quote a Business Week article:

Huabao International Holdings Ltd. (336), a maker of flavors and fragrances used in cigarettes, suspended trading in Hong Kong after the stock plunged on a short-seller report that questioned its finances.

Huabao fell 8.1 percent to HK$3.98 at the close in Hong Kong yesterday after short seller Anonymous Analytics said the company “reports absurdly high margins, which industry sources say should not be possible.”

The company didn’t give a reason for the suspension. In a Hong Kong stock exchange filing late on April 24, Huabao said it wasn’t aware of any reasons for the changes in its share price and trading volume.

Monday, April 16, 2012

It is the holiday part of the trip and I was strolling through the back-lot footpaths of Venice with my twelve year old son. We were doing out best to get lost (surprisingly easy) and I had given up worrying that my wife had (dangerously) gone shopping.

It was four hours chatting to the boy about business and history and life without the interruptions of computers, phones or video games.

We also talked at length for the first time about our business. We run a hedge fund. Our job is simple: make rich people richer through investing, trading in financial markets.

Half of that is relatively easy to explain: we buy shares in good companies. My son wanted to know why I was not interested in buying Facebook (he thought the shares are going up). I told him that it had 4 billion in revenue, 1 billion in profits and a market cap that was likely to edge 100 billion. The numbers are from memory (I am on holidays). That seemed expensive. However it was only about $200 per regular user which does not seem so expensive. I did not think I could analyse it well. This was the beginning of a discussion about price.

But then the area our fund is best known for came up. I am a short seller.

I went through the mechanics of short-selling. I borrow a share from a broker. I sell it in the market. If the stock goes down I get to buy it back for less than I sold it. I repay the loan by returning the share and I keep the profit. I explained it does not work so well when the stock goes up.

Then I got to the nub of the issue: I am a short-seller of frauds and stock promotes. I look for people in the stock market who have fake accounts and who are stealing from gullible shareholders (also known as marks, dupes, fools, day traders or mutual fund managers). There is a torrent of money being ripped off (many billions of dollars for instance in the case of the Chinese frauds a surprising amount of which came from Fidelity). Through short-selling I stick up my sail on my little boat in the hurricane of theft and some of that loot drops into the cabin.

He asked me how I find all these fake accounts and fake companies and I told him a few of our methods (we have many).

He asked if I ever dobbed the scammers in to regulators and I said I did sometimes but it was mostly not a satisfactory experience. To be a good short-seller I only need to be right about 90 percent of the time. If most the companies I short-sell have fake accounts I will do fine. However if I dob them into regulators I need to be absolutely right in that it does not bode well to dob an honest person into the authorities. So mostly I keep my gob shut and express my opinion (and it is an opinion) in a bet in the financial market.

Moreover talking about which stocks you think are frauds is a dangerous thing. Regulators sometimes (even foolishly) have been known to investigate short-sellers for telling the truth. (Being short Lehman Brothers and vocal about it was a good way of getting an SEC investigation for talking truth to power.) Also crooks sue short-sellers giving you nasty and expensive legal bills.

Silence is altogether a better strategy.

But then he came to the nub of the issue. The easiest scammer to find is a repeat offender. We actively seek out people who promote dodgy stocks and who who are repeatedly involved in dodgy companies. The slogan is “once a scumbag, always a scumbag”. That slogan is probably not strictly accurate - but we only need to be right 90 percent of the time to be fantastic at this business – and the recidivism amongst scammers is surprisingly high.

In that sense long sentences for people like Bernie Ebbers are not in my interest. I would prefer slime-bags to be back-in-business rather than in prison. More opportunities for me.

So, perceptively my son asked whether it was in my interest to dob scammers into regulators – he asked whether the reason we did not do it much was because of the reasons stated above or because we liked the scammers to be free and profitable. Alas – and I had to confess it – at least part of it was that being a successful short-seller required that regulators were inadequate to the task of policing fraud.

I did not talk about this with him – but it is becoming harder under Mary Schapiro. The SEC is getting better at their job – and that is not good for me. It would be better if regulators stayed hopeless. Alas they are getting better.

So, says my son asks you like nasty people to steal from poor investors, mutual funds (and he did not say pension funds for school teachers) so that you can join them in taking the loot by being a short-seller – and you don't want the regulators to do anything about it because there are more opportunities for you?

Sheepishly I confess yes.

And he says with a mixture of admiration and horror: “daddy you are more evil than I thought”.

John

PS. A long time ago I promised Felix Salmon an economic defence of short-selling. I did not deliver – but it is sort of written in my head. I think I owe it to my son too.

Friday, April 13, 2012

On my travels I found myself in a fine hotel in Central Milan. I came in about Midnight the previous night from London (courtesy the atrocious service of Easy-Jet*).

At 6.15AM I was up for my morning meeting - via a fast-train to Bologna. My shirt was clean courtesy the expensive London laundry. I just wanted an ironing board to press out the wrinkles.

There was not one in the room - so I rang reception. I asked them to bring one up. They said "impossible" which I found peculiar. An ironing board is a pretty standard service in a 4 star business hotel.

Then they explained that they could not get one before 7.30 (which was just before my train left). I said this was a bad fail for a business hotel.

Then they said something that was so stereotypical Italian it left me breathless. They told me it would be against the law to bring an ironing board to my room before 7.30 am.

I told this to my Bologna business contact and he scoffed. Of course somewhere in the 10 million lines of Italian code there is - of course - something that talks about ironing boards. Dysfunctional government (at least by the standards of OECD countries) is an iconic feature of Italy - but this was not government as a problem - it was government as an excuse.

At least Easy-Jet don't blame the government for their bad - even rude - service.

John

*If anyone knows why European discount carriers are so horrible but Southwest (surely a similar model) is so pleasant (at least in a relative sense) let me know. In the USA I will fly Southwest in preference to any other airline. In Europe I am learning to avoid the discount airlines.

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A post script is warranted: Part of my dislike of Easy-Jet had to do with a ridiculous overcharge of GBP12. Trivial really. However when I complained at the counter the discussion had the tone of "I can see you are right but our computer won't let me refund the money so sorry". Silly stuff that indicated process over service. And I had 90 minutes at an airport and was frazzled. Not a good combination. I did not raise my voice - just walked away frustrated.

In frustration I wrote a (nasty) letter to them. I do not think they linked me to this blog - but they refunded the 12 pounds. I think that marks them as several steps better than Ryan Air. I have not quite forgiven but I think I am prepared to give them another go.

Thursday, April 12, 2012

I do irregular (but extended) business travel. (It comes from living in Australia – when you travel it is usually more than a week.)

And so I find myself needing to wash and iron business shirts and press a suit. Nothing complicated – but strangely the price and procedure changes by country. In New York I usually stay in Brooklyn and my walk to the subway takes me past a Chinese laundry which is breathtakingly cheap – my bag usually costs under $12. That is about a quarter what I would pay in Sydney (which is an expensive city for almost everything) and a third London. Brooklyn seems cheaper than other US cities.

This low-cost laundry (clearly a benefit to me) is made possible by a near-sweatshop centralised Chinese laundry where (immigrant) workers work hard for what may or may not be minimum wage.

When I wrote a post about that I was criticised for daring to state the obvious about income inequality in the United States. It is a taboo topic. In my defence several readers noted that investment bankers regularly press their own shirts in London. I certainly do in Sydney.

When I stayed in a friend's house in Chicago I discovered much to my surprise they did not have an ironing board. I thought it worth a blog post. And whilst the underlying tone was that income inequality was not the finest attribute of a society I have to say it is not entirely a bad thing. The couple I stay with in Chicago are a monstrously successful husband and wife team with children. Very few married women with children pull that off in Sydney – and the reason was obvious. The wife's work life (high profile but only moderately remunerative) relied more than a little on the two nannies and the implied low-wage workers (such as the staff at the local laundry) who relieved her of the mundane house-work that fills many (mostly female) lives in Australia.

This was feminist achievement made possible by income inequality. But it was achievement at a very high level and the USA is better for it.

This trip I stayed at a friend's apartment in Hong Kong. Nice place – not huge – but half-way up the Mountain on Hong Kong Island with an expansive view of skyline (when you can see through the pollution).

I asked to borrow an ironing board. My friend said he could do better. He knocked at a small door past the closet next to the kitchen and out popped a Filipino house-keeper maybe 20 years his senior. She cheerfully laundered my clothes and left them neatly pressed. She also made me breakfast, cleaned up my dishes and made my bed when I went to work.

I made a point of trying to work out her story. She had been a migrant worker throughout her life – mostly in Hong Kong but also in Dubai (which she found harder). She was thinly educated but thought her children (who she had spent years away from) were better prepared than her. The reason for migrant work was to educate her children (though I know nothing about their prospects – the Philippines are not a highly functional place). Unlike Harry Potter she did not show any unhappiness in living in the “cupboard under the stairs”. Instead it was a step-up for her and (especially) for her family. And it was better than Dubai.

But it made me deeply uncomfortable. Migrant workers are a profoundly anti-democratic institution – they provide a class of very-low income people who don't vote. The ethos of democracy is something burnt into my consciousness. In this ethos we are “created” equal (and thus have an equal vote) and dint of luck and hard work (or coming from the right womb) produce inequalities (some deserved, some otherwise). But the vote (hopefully a secret ballot) is one of the great equalisers – and acts to create a more harmonious society (albeit one that will interfere with income distribution to some extent). The woman who cheerfully lived in the cupboard under the stairs challenged what I thought was right in the world.

But then I was in Hong Kong (that is China) and another low-wage worker who does not vote in China seems – well – somewhat irrelevant. And my world view was out of place. Moreover the woman's children were clearly better off for her migrant work. And the Philippines would be a true basket case without remittances.

And low-income workers are a gift to those who get to employ them. They make the Feminist achievements of my above-mentioned Chicago friends possible. They can free productive people to work on things that were productive.

And that was clearly the case for my friend – consciously trying to pick up additional commercial languages (think India), improve his computer processing skills (python) and read a book per week. His ambition to build himself into as fine a thinker (and with as many diversified mental models) as Charlie Munger. Human capital development made possible by the profoundly undemocratic institution of migrant work.

But that was not the only thing people do with their wealth in Hong Kong. Hong Kong Island has become a pastiche of office towers for financial businesses and shopping malls selling the global standard set of luxury goods. Interspersed amongst that are stylish but ultimately vacuous bars where you can get wasted in the time you would have otherwise spent ironing your clothes and doing the dishes. It is not far (just a subway) from Kowloon where you can experience the smells and sounds of Asia – but they joke on Hong Kong Island that you need your passport to go there.

This is a world very different to mine – with some amazingly productive people – their productivity made possible by the institutions of China. Interspersed amongst that the most dilettante hedonistic lifestyle of an elite who can think of nothing better to spend their loot on than Swiss watches and French Brandy.

Whatever: I am going to make a confession. I liked having someone launder my clothes and the stylish bars are very cool. Freeing up all that time to read an extra book per week – that would be very cool too.

General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. Mr. Hempton may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Hempton's recommendations. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.